COF Syrup Needed?

-By Josh S | [email protected]

Capital One Financial (COF) Reported first quarter results last week and saw its share price decline. Q1 net income was $810 million or adjusted at $1.75 per share. The adjusted results exclude a reserve build in COF's U.K. Payment Protection Insurance program. of $99 million.

The company had to revise its charge-off guidance, which will now be in the high 4's to around 5%, which is up from mid 4%'s. Loan losses from 2016 are not "seasoning" as planned. The company remarked that there is more consumer indebtness and COF has cutback on growth. COF now says efficiency will be around 51%—down from 52%. Efficiency helps investors as it is non interest expense divided by total revenue (net interest income + non interest income). A lower ratio means higher profit, all things being equals. The company reiterated its forecast for solid EPS growth in 2017—of 7% to 11% adjusted EPS growth in 2017.

Net interest margin increased 3 basis points in the quarter to 6.88% even despite their being fewer days. Higher net interest margins mean COF earns more for each loan on average. Ending deposits were also up about 6% versus the prior year—and $3 billion from Q4. Deposits typically indicate a low cost and sustainable funding compared to other sources such as wholesale funding. Furthermore, retail deposits are seen as more valuable than deposits by other banks and institutions—deposits from hedge funds or other banks get labeled as "non-operating deposits". The esoteric term can be defined as deposits that the FDIC would not insure because they are too large—for instance deposits from another bank or hedge fund. Basel III regulations require banks to hold 40% of high quality assets against hedge fund non-operating deposits and 100% for non-operating deposits assets from other financial institutions—only 3% is required for operating deposits—or regular customer deposits. The new rules assume banks will have 100% withdrawals, in a period of stress, from other financial institutions, a situation which is unrealistic because it assumes all banks withdraw their money at once .

COF says they are cautious of the auto industry as the consumer has become indebted; It expects higher charge-offs and lower growth going forward. The company also announced "significant capital distribution" subject to regulatory approval. Fairbank, the CEO of COF, clarified his remarks on the "coiled spring" metaphor, which he discussed over the last year. The coiled spring would typically be a metaphor for something that is storing energy that is waiting to burst at any moment. However, Fairbank now says his metaphor doesn't mean this. He clarified, "but to be fair, the uncoiling is not a moment in time. This is a phenomenon that happens as the vintage curves from a bunch of programs gradually settle out, the loss curves gradually decline and there's just a continual uncoiling that goes on as that happens."

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